Blockchain Applications in Commercial Real Estate? How, Why and When?
July 11, 2018 | James Sprow | Blue Vault
In 1976, this author had the opportunity to pose a question to Frank T. Cary, then CEO of IBM, at a party. I asked, “What do you do for an encore? You have 70% of the computer mainframe business, what’s next?” His answer was very succinct: “We’re going to make computers easier to use.” I remember going home later thinking how ridiculous that sounded, unaware that across town in a Palo Alto garage, two young guys named Jobs and Wozniak were creating the first personal computer that was indeed, “easy to use.” During Cary’s tenure at IBM, the company introduced the Selectric typewriter, a Winchester hard drive that doubled the capacity of other hard drives, a 50-pound “portable” computer, and in the last year before he retired at 60, the first IBM personal computer. He was right on, able to express in just a few words what the next “big thing” would be in computers, and I was “unaware.”
In 1991 while teaching at a state university, this author sought help with a computer problem by consulting our two techies who were responsible for managing the college’s computers. While waiting for their attention, I overheard them say something like, “Let’s check with the University of Michigan’s system to see if it is there.” Little did I know that some of the major research universities at that time were linked via a network first developed by the U.S. Department of Defense (ARPANET) that was the technical foundation of the Internet. Little did I know how the Internet, and personal computers, would dramatically change our lives.
Fast forward 27 years, moving from my first Apple McIntosh (512K RAM!) to my first “bag phone” and on through numerous iterations of laptops and cell phones to the present day, and there’s a realization that the next “big thing” may just be this technology called “Blockchain.”
It’s déjà vu all over again, as Yogi would say. An article appeared in September 2017 entitled “Why Blockchain May Be Key to IBM’s Future.” The author describes how “IBM’s legacy businesses are in decline; we think technologies such as blockchain and cognitive computing are its best hope for recovery.” Frank Cary, if he were alive today, might say, “We’re going to make all kinds of transactions easier and more efficient.”
Blockchain is a decentralized and distributed ledger originally designed for bitcoin as a means of preventing bitcoin users from scamming the system and spending their cryptocurrency more than once. Just as the internet had much broader applications beyond research universities and our government transmitting data, the blockchain technology has applications in business that are far-reaching and quite simply, revolutionary.
IBM has been running advertisements that show how blockchain can track, in real time, the flow of food products from producer to wholesaler to consumers, and record and verify each step of the process. Blockchain technology and its distributed ledgers offer an immutable record of all kinds of transactions and information that allows a user to access a complete and accurate history of an almost limitless variety of activities, from banking, to healthcare, to real estate. Most major financial institutions, for example, are currently integrating blockchain technology to track financial transactions. The healthcare system will use blockchain records to make our health records more accurate and readily available to our caregivers while maintaining security using powerful encryption tools.
So how might blockchain applications revolutionize commercial real estate investment?
Let’s narrow our focus to just one sector where blockchain applications may soon impact commercial real estate investors and the sponsors of commercial real estate investment programs such as nontraded REITs.
Nontraded REITs have, since their inception in the early 1990’s, raised over 100 billion dollars from retail investors and invested this capital in portfolios of commercial real estate properties, offering income via cash distributions and, eventually, liquidity when the companies have either been listed on national exchanges or liquidated through merger or sale. While the typical nontraded REIT program has indeed delivered income along with diversification into an asset class with low correlation with traditional investments like stocks and bonds, the critics of the nontraded REIT structure have focused on their lack of liquidity, lack of transparency, high fees, and unpredictable life cycles. Investors have until recently been “locked in” to extended holding periods and had only periodic valuations to estimate the net asset value of their common shares.
With the advent of daily NAV or monthly NAV nontraded REIT formats, both valuation transparency and liquidity have been improved, allowing the nontraded REIT structure to evolve to better satisfy investors. Fees have also been coming down, with multiple share classes to meet the demands of individual investors with different types of investment accounts as well as institutional investors.
Blockchain technology has the potential to make commercial real estate investments and nontraded REIT programs more efficient in the following ways:
|•||Blockchain transactions can allow nontraded REIT shareholders to buy and sell their shares in secondary markets that utilize the same technologies as other securities exchange platforms.|
|•||Blockchain can be used for original issue of nontraded REIT shares, lowering the costs of distribution and capital raise by reducing the expense of the current network of intermediaries.|
|•||Blockchain will enhance discovery, transparency, and communication between program sponsors, financial advisors, broker/dealers and market makers.|
|•||Blockchain transactions will make the settlement process more efficient, allowing changes of ownership to take place in minutes rather than days or weeks.|
|•||Utilizing “tokenization” of shares representing ownership in commercial real estate properties will allow investors to inexpensively diversify their own commercial real estate portfolios, receive distributions and financial reports, and liquidate their holdings at their convenience in competitive markets.|
|•||Blockchain’s “smart contracts” can ensure that transactions conform to FINRA/SEC regulations.|
Blue Vault is aware that several ventures are working today to make blockchain applications to commercial real estate investment a reality. We will see very soon the introduction of new venues where nontraded REIT shares can be bought and sold in secondary markets, freeing up capital that is currently “locked up” for some investors for an indeterminate holding period. Eventually, nontraded REIT program sponsors may also use blockchain applications to offer investors direct access to new shares.